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8/8/2019 Lecture 1 - Purposes, Users and Content of Financial Reports
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NBS8227 Analysis of
Company Accounts
Lecture 1 Purposes, Users and
Content of Financial Reports
By
Laurence Ferry
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Learning objectives
Explain the nature and role of accounting
Identify the main users of financial information andtheir needs
Identify the different types of business entity List the influences on preparation of financial
information
Explain the accounting equation
Explain the components making up the accountingequation
Understand the limitations of financial reports
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What is accounting?
Accounting is the process ofidentifying,
measuring and communicating financialinformation about an entity to permit
informed judgements and decisions by users
of the information
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Analysis of Company Accounts
Various types of profit making organisations
Sole trader
PartnershipPrivate Limited Company
Public Listed company
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Analysis of Company Accounts
Publicly listed companies are more heavily
regulated than private companies
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Company
law
International
accounting
standards
External
accounting
rules
Stock Exchange
Sources of accounting regulations for a UK limited
company listed on the London Stock Exchange
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Analysis of Company Accounts
Regulation is necessary due to :-
Gap between owners and preparers of accounts/ those
managing the organisation
Reliance by stakeholders as no other source of
information
Stakeholders include, shareholders, employees,
bankers, creditors, debtors, trade unions, publicinterest, government agencies, pressure groups.
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What qualities should accounting information have -
usefulness
Characteristicsthat make
financial
information
useful
Understandabilit
y
Comparability
ReliabilityRelevance
Limitation to the
application of
the qualitative
characteristics
Cost/Benefit
Necessary for
including
information in the
financial statements
Materiality
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Preparation of Company Accounts
Conceptual Framework (IASB)
Sets out general guidance about what should be reported infinancial statements
Considers the following:-
1. Users and their needs
2. Objective of financial statements (GPFR)
3. Underlying assumptions
4. Qualitative characteristics of financial statements
(understandable, relevant, reliable and comparable)
5. Elements of financial statements
6. Recognition and measurement of the elements
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Preparation of accounts
Influenced by:-
Accounting concepts
Conceptual frameworkAccounting standards
legislation
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Analysis of Company Accounts
Preparation of Accounts
The regulatory framework for accounting in the form ofAccounting standards lays out the measurement anddisclosure rules to be followed.
There are also general assumptions used in thepreparation process and these are called accountingconcepts (refer Pendlebury and Groves)
Some of the concepts are questionable and may evolve
to reflect current developments
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Accounting concepts
Accruals
matching
prudence
Money
measurement
Going concern periodicity
realisation
consistency
materiality
Cost
Entity
Preparation of accounts
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Financial Reports
Consist of:
Income statement (Profit and loss account)
which shows revenue and expenses Balance Sheet shows assets, liabilities and
shareholders equity
Cash Flow statement
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IAS 1 Presentation of Financial
Statements
According to IAS 1, the financial statements consist of:
Income Statement (Profit & Loss account)
Statement of Financial Position (Balance Sheet)
Statement of Changes in Equity Cash Flow Statement
Notes on accounting policies and other explanatory notes
The concept of fair representation
Why do you think IAS 1 says fair representation ratherthan correct or accurate presentation of the financialposition? (Hint: think of depreciation of non-currentassets)
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IAS 1 Income Statement
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IAS 1 Balance Sheet
Assets = Capital + Liabilities
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IAS 1 Statement of changes in equity
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IAS 7 Cash flow statement
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Accounting Equation
Accounts are prepared on the basis of the
accounting equation, i.e.
ASSETS - LIABILITIES = OWNERSINTEREST
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Accounting Equation- Assets
Assets
A resource controlled bythe entity as a resultof a pasttransactionfrom which future economic benefits are expectedto flowto the entity
Controlled ability to enjoy benefits and restrict othersaccess (not necessarily owned)
May be split between current and fixed (non-current)
Assets are recognised when it is probable that the economic
benefits will flow to the entity and can be measured reliably(usually at cost)
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Assets
Examples:
Land & buildings
Plant & machinery
Raw materials
Cash at bank
Classified as:
Current assets
Non-current (fixed) assets: intangibles & tangibles
Recognised in balance sheet: future economic value & measurable
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Accounting Equation
Some problems with recognition and
measurement of assets:-
o Human resource accountingo Reputation of the business
o Quality of customer base
o Tax refunds in the future
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Liabilities
A present obligation of the entity arising from
the past events, the settlement of which is
expected in an outflow from the entity of
resources embodying economic benefits
Present obligation refers to a liability to
another entity having a legal claim on the
organisation
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Liabilities
Examples of liabilities include:-
Bank loans
Trade payables
Taxation payable
Accruals Provision for deferred taxation
Long term loans
Liabilities are also classified into current and non-current, similarto assets
Liabilities are recognised in the balance sheet if it is probablethat there will be an outflow of economic benefits and theamount can be measured reliably
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Liabilities
There may be liabilities which fail the recognition test andare therefore not shown in the balance sheet (BS). It isimportant to review the notes to the Financial Reportsthoroughly for items such as contingent liabilities
Items which may not be shown in the BS are:- A commitment to purchase fixed assets after the year end
A remote liability for a defective product
A guarantee given to support a subsidiary where the
guarantee is unlikely to be called upon
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Ownership interest
Ownership interest is also known as shareholders
funds, shareholders equity.
In accounting once owners invest money it is
recorded separately. Subsequent profits earned areadded to the investment
This is the residual interest in the net assets (i.e.
assets liabilities)
Any assets acquired will either be financed by
liabilities or owners equity.
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Ownership interest
In companies the ownership interest is in the
form of shares (ordinary and preference
shares)
Naturally if net assets increase the owners
equity will increase too
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Revenue and Expenses
Revenue is created by a transaction or event duringthe ordinary activities of the entity which causes anincrease in the ownership interest. E.g. sale of stock
by a book seller will increase revenue, decrease stock Expenses is caused by a transaction or event arisingduring the ordinary activities of the business whichcauses a decrease in the ownership interest e.g.utility costs for the bookstore will reduce cash andincrease expenses
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Worked example
Books Galore provides the following information:-
The business was incorporated with 10,000 shares of 1 each fully paid incash. During the year the business borrowed 5,000 to assist inrenovations. Sales were 20,000 (debtors 5,000)
Purchases of books 10,000 (creditors 2,500). Interest paid on
borrowings was 500. Utilities were 1,000 and salaries paid 4,000.Administration costs were 2,000 all fully paid.
Required
1.What is the ownership interest at the beginning of the year when thebusiness was incorporated?
2.What is the net profit for the year?3.What is the ownership interest at the end of the year?
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Worked example cont:
1. Ownership interest at incorporation.
Using the accounting equation of A= L +OE
BALANCE SHEET:
CURRENT ASSET
Bank 10,000
OWNERSEQUITY
Issued share capital 10,000
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Worked example cont ;
PROFIT & LOSS ACCOUNT:
2. Revenue 20,000
Less Purchases (10,000)
Gross profit 10,000
Less Operating Expenses
Administration costs (2,000)
Salaries (4,000)
Interest costs (500)Utilities (1,000)
Profit for the year 2,500
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Worked example con:
3. Owners Equity at the end of the year
BALANCE SHEET:
CURRENT ASSETS
Bank 15,000
Debtors 5,000
Less LIABILITIES
Creditors (2,500)
Bank Loan (5,000)
12,500
OWNERSEQUITY
Issued share capital 10,000Profit 2,500
12,500
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Relationship between the balance sheet & income statement
Income statement 1
Balance sheet at
the end of Period 1
Balance sheet at the
beginning of Period 1
Balance sheet at
the end of Period 2
Income statement 2
TimePeriod 2Period 1
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Analysis of Company Accounts
Limitations of financial reports:
1. Basis of preparation2. Timing of release
3. General purpose, not meant for specific
purpose reporting4. understandability